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Thursday, 8 January 2015

Avi-Tech Electronics (CT1.SI) – Is Quick Profit Possible?

In my post
on My SG Portfolio 2014 and Some Recent Picks, I’ve mentioned that one of my
event-driven picks for 2015 is Avi-Tech Electronics. I think price then was about
S$0.074 and I’ve accumulated since November at an average price including costs
of S$0.699. There are some interesting comments in the post (you should read it here) and I thought that
probably it’s good to write a short article about my analysis.

Avi-Tech
Electronics is listed on the SGX and is a provider for Burn-in, engineering
and manufacturing services in the semi-conductor & electronics industry. In
2011, It ventured into the Imaging Equipment and Energy Efficient Products by
starting 2 subsidiaries to ‘diversify and substantiate long-term growth’ for
the company. Guess what happened in the end: since 2011, the company began incurring losses largely
due to these same subsidiaries and management has finally decided to discontinue these operations just a couple of months back. Originally, the classification of this type of
purchase in my portfolio (see post for more details about this) do not require intensive
analysis – so I’ll try to keep things simple here. The following data are based
on my 30 Dec 2014 post:

Investment Thesis

The results
in this classification of stocks depend a lot on corporate events which in some sense
serve as a catalyst to close up the price-value gap, hopefully in a fairly short period of time. My investment decision is
premised on the following:

The management has destroyed huge value over the years from the 2 loss-making subsidiaries. Many shareholders could have loss confidence with management's ability and decided to sell / cut losses.

The poorer fundamentals and financial results combined with the inclusion onto the SGX watch-list due to 3 consecutive years of pre-tax losses has led to a stock price decline that is likely over-exaggerated.

This exaggeration led to a fair degree of undervaluation which also means a potential investment opportunity to the shrewd analyst.

Directors have been mopping up shares recently with their own money and to that extent, agreeing with my view that the stock price might be undervalued.

The disposal of subsidiaries which are main contributors of past years' losses may improve future earnings at least in the short term and this may prop up the market price.

Key Risks / Uncertainty

Management indicated that they will “continue with its plans to seek new areas of
growth whether through mergers and acquisitions, or any structured transaction
or business, which will add value to shareholders.” Has management really
learnt their lesson from previous experiences? Are they capable enough to
continue ‘adding value’ through acquisitions? Personally, I feel its foolish for them to do that considering their
core business ain’t doing as well as before too (more details below).

Also,
we can’t deny the fact that they are in a difficult semi-conductor
industry which presents a challenge to the management (that is
perhaps why they insist on growing through acquisitions etc) and a risk that the investor need to be wary of.

Safeguards and Checks – In case things do not
turn out well

Like I say, the need for intensive analysis is not really required for the event-type part of my portfolio and I hope to realize some profits in a reasonably short period of time. However, as a safeguard, I better ensure there’s some sort of margin of safety if things don’t work out and I might have to hold on to it for a longer than expected timeframe. Since this will be a minor position in my portfolio, a brief analysis should be sufficient.

Financial Position

The balance
sheet is generally cash rich with net cash equivalents of about S$23.5M which compares
favorably to the market cap at S$25.3M. Book value is about S$40M. If the
company is liquidated now, I believe we can get back more than what we pay now.
Of course, if management continues eroding value by doing foolish expansions,
the intrinsic value on a liquidating basis may drop below our price paid in
light of such later developments in the business.

Earnings

Avi-Tech Electronics Financial Summary

I’ve cleaned up the effects
of the loss-making subsidiaries in the above table and it is clear that these
subsidiaries have indeed eroded earnings between 2011 and 2013, before management
decide to discontinue operations in 2014. The core operations haven’t been doing well too considering that they also have registered
some losses between 2012 to 2014. Core business revenue has declined
drastically from S$70M to S$23M over 7 years.
However, keep in mind that the
bulk of the negative earnings is attributed to the subsidiaries (contribution
by subsidiaries is -S$12.8M compared to +S$1.7M for core business from 2011 to
2013).

Valuation

Not surprisingly, thanks to these loss-making subsidiaries, share price has declined more than 60% since 2011. The discontinuation of the subsidiaries has stemmed losses greatly and results in 1Q2015 shows a positive profit. Could there be turnaround which can lift share price higher? No one can say this for sure.

Avi-Tech Electronics 5 Year Stock Chart

Let's use 2010 and 2015 results for comparison since in both years, the loss-making
subsidiaries are non-existent. A back-of-the envelope calculation shows PER of
2010 is about 15.6X while forward PER of 2015 appears to be about 9.1X (I
annualized 1Q15 earnings per share of S$0.002 here as an approximation). Assuming all else
remains the same, this could be another indication that share price decline has
been exaggerated and the market probably has not factored in the positive effects
from the disposal. If valuation in 2010 is any guide, the market price should
be priced around S$0.12! Of course, I’m not saying these assumptions are
reasonable but at least it gives me some level of comfort here knowing that I'm not buying at a ridiculously high price.

Because the earnings has been quite unstable, probably the balance sheet can give better insights
about its intrinsic value. Taking a haircut of 50% to PPE (NB: this part of the
balance sheet is throwing in some S$500K-S$700K rental income annually), 25% to
inventory and 10% to receivables, we get a liquidation value of S$0.094 per
share as compared to the price of S$0.074. (Potential Bonus 1: I did not include the proceeds that the
company may receive from the disposal of subsidiary in this valuation).

Conclusion

A
high price can turn stocks of good quality businesses into a speculative
purchase and likewise, a low price can turn a speculative stock into an
attractive investment. My opinion is that Avi-Tech belongs to the latter.
Considering the pros and cons, I think the low price coupled with the existence
of potential catalysts make the purchase of Avi-tech too attractive to be
denied by the security analyst. However, the risks mentioned above also means
that the sizing of the position in the portfolio should be kept relatively
small - just in case management screw things up again. (Potential Bonus 2: we
already ensured there's some margin of safety to absorb unfavourable future
developments but what if by some freak nature, the future acquisitions are so
successful that future earnings improve dramatically? This is definitely not accounted
for yet).

Some Final Thoughts

Due
to it’s classification in my portfolio & unless there’s any clear-cut
change in circumstances, my guess is that I will take most of my profits (if
any) within the next 12 months. I mentioned that my average price purchased
including costs since November ‘14 is S$0.0699. Price now at S$0.078 would mean that my
current returns is about 12% in slightly less than 2 months. Obviously this is
not the best business in the best industry and I have the urge to take my
profits initially when it was at S$0.08. After some deliberation, I figured that my estimate of
S$0.094 is really a minimum valuation which is so conservative to the extent
that it is a reasonably dependable guide. Moreover, one of the directors bought back shares a couple of days back at about S$0.078. Maybe somewhere around S$0.09 I can consider trimming
my stakes. I would be more than happy to get some opinions about this.

PS:
I’m surprised that I took about an hour of analysis before my decision to
purchase Avi-Tech but it took me more than 3-4 hours to write it in this blog!

6 comments:

Seems this company has trouble finding ways to make money? It's longer term prospect doesn't sound exciting.

Be careful of considering liquidation value based on its current cash. Check how much it burns as well. Can disappear quickly due to operating expenses if it isn't generating profitable sales. That margin of safety may not exist.

Thanks so much for visiting my blog. I think you’ve raised a valid point here. The longer term prospect doesn’t sound exciting at all. However, I believe the beaten-down price coupled with the various corporate actions that act as some sort of catalyst have made the stock a potentially attractive investment.

With regards to liquidation value, I’ve used it as one of the indicators of the company’s value. Like I mentioned in this post, between 2011-2013, the bulk of negative earnings are attributed to the subsidiaries (they contributed –S$12.8M while core ops contributed +S$1.7M). These loss-making subsidiaries are the exact same ones that management will discontinue and this will help stem much of the losses. Core operations endured comparatively minor losses which was worst at -S$1.61M in 2013 (VS subsidiaries –S$7.6M in 2012). 1Q2015 shows core business operating profitably signalling a potential turnaround.

With these, I believe the company is unlikely to burn as much cash as the past 3-4 years and correspondingly, the liquidation value can be used as a reasonable guide to its valuation at this point in time. Of course, the future is unpredictable and management can still burn cash in the future, especially through similar unsuccessful acquisitions. What I can say is that I did not place any positive prospects of the future in my valuation while the negative prospects are still guarded by some indication of margin of safety.

All in all, if I can find a few companies in this investment situation and at this price level for my even-type portfolio, I think the probability of profiting should be high overall. If you read my previous post on My SG Portfolio 2014 and Some recent picks , you will notice some companies in my event-type situations aren’t doing very well operationally and doesn’t seem to have bright prospects (one of them is facing a lawsuit too). I guess the point here for me is that because of these past losses, the price of Avi-Tech had been beaten down by investors/speculators to a point so low that they have essentially assumed these losses are very likely to continue far into the future.

I've read this quite detailed and done some research a little bit on my side.

I think you've done a very good job in highlighting the strength and weaknesses for this company. The cash and fd portion are certainly enticing which makes up the majority bulk of its asset. The PPE portion accounts mostly their building and some computer cost, so unless you are talking about liquidating value at this point in time, they would eventually get depreciated fully anyway.

The increase in the AR Working capital is a little growing concern for me. If there is a chance, it'll be good to thrash out with the management to ensure that this does not keep increasing beyond.

The company has a huge cash to deploy which they have mentioned for expansion and working capital purpose. I have mentioned about my worries for the latter because simply they have too much cash that they can actually sustained this loss of negative working capital. But if they use the right resources for the right expansion, this could be a big bonus in disguise.

I am not too familiar with the business to do a forward projection on the business. I think the key is to understand well why the investment on subsidiaries have made losses and to ensure that they don't repeat such mistakes in investment again.

But at 0.069 cents you have certainly enter at a very good entry point, so I will just ride out if I were in your position, given that the management has mentioned they will receive further sales revenue from the sales of their impaired assets of APLEGEN in 2015.

Thanks very much for your continued support and response in my blog. Always appreciate your sharing and insights.

For PPE, you’re definitely right about the current liquidating value but I just want to highlight the fact that even on an ongoing basis, the PPE (despite it being fully depreciated fully in future) should be given some value since it supports the earnings power of the company now and at least for the next few years. Am I not right in this regard?

Probably the tough part is to determine or assign a value to it as a going concern. Perhaps one quick and dirty way to estimate is to calculate the DCF of the potential net rent received by the company and give a minimal value to other equipments etc. Whether this final value will be more than the current S$12M stated in the balance sheet I can’t be sure. Would really appreciate if you could share with us if you have any other alternative methods about this.

I assume AR means accounts receivable? I just had a quick look at it and personally feel it’s not very serious. I thought the accounts receivable turnover has been fluctuating within a reasonable range. Perhaps you can elaborate more or that?

Lastly, I sure hope the company will deploy the cash efficiently and effectively. If not, the margin of safety might be eroded further. The management has explained the rationale behind the subsidiaries when they started it and have also explained why they discontinue them. This mismatch in attitude is clear that they lack genuine foresight, just like most of us. No bonus points for the management over here.

Thanks for your advice about riding out the stock prices. Will remind myself about it before I make any hasty decisions!

The problem with companies having a lot of cash is they can do something spectacular with it or screw things up and things will still be okay because of the cash. It's definitely a question mark down there. Same with companies like Vicom, Supergroup, Sheng Siong, etc.

But I think you've made a very good entry point so your margin of safety is much higher than investors who enter at the current price.

Yes I thought my entry price is pretty reasonable. Actually I started buying up in phases from S$0.062 onwards after my initial research and got an average price of S$0.0699. Hopefully, the price will get to my estimated value soon :-)